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Direct Intervention

The Central Banks, in order to achieve various economic objectives intervene in the foreign exchange market. There are various reasons for the intervention of the Central Banks in the foreign Exchange Market they can be stated as – Our tutors atTranstutors.comprovide very efficient and marvelousfinance homework and assignmenthelp at a very reasonable price.

- To stabilize the fluctuations prevailing in the exchange rates in the economy.

- To influence the level offoreign exchange reservesin the country.

- To reverse thetrade deficitgrowth in the Country.

The Central Banks intervene in the foreign exchange markets both by the way of direct intervention as well asindirect intervention. Central Banks adopts the method of direct intervention with the motive of effecting the foreign market by buying and selling the domestic currency in the market. Again a Central Bank intervenes indirectly by raising or lowering the exchange rate through domestic supply changes.

1) Here in this case the Central Bank can raise or decrease the value of its currency and the scope of direct intervention is limited to that only. In case the Central Banks wishes to raise the value of the domestic currency then it would buy the domestic currency from the market and sell the foreign currency and this would appreciate the domestic currency apparently and the value of foreign currency deflates.

Let us take an example- The domestic currency is suppose dollars and the foreign currency is suppose pound, in that case if the Central Banks if they want to appreciate dollars in that case they buy the dollars from the market and flows pound in the market, this will decrease the value of the pound and the dollars value would appreciate gradually.

2) Again, the Central Bank can decrease the value of the currency by selling it in the domestic currency in the market and buying the pound from the foreign market. If the domestic currency is sold then it would decrease the demand for the currency and would inflate the value of the other currency and deflates its own value.

Let us take an example- The domestic currency as we have taken is dollars, so in this case the bank will flow in the dollars in the market by selling it in the market, the demand for dollars will fall rapidly and it would depreciate the value of the dollar with respect to the other currency in the market.

These were basically the two roles played by the central bank by intervening in the foreign exchange market and influencing the value of the domestic currency by different measures.

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